Michael Gray, CPA's

Real Estate Tax Letter

July 3, 2008

© 2008 by Michael C. Gray
ISSN 1930-0387

A monthly report focusing on tax issues for the homeowner and real estate investor.

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Happy July 4!

Hope you and your family enjoy a great July 4! We get a three-day weekend this year.

Be extra careful with fireworks this year. If you live in California, you know there are many wildfires burning throughout the state. There might not be many firefighters available for emergencies right now.

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Can you believe the year is half over already?

How is your year going? Despite all the "doom and gloom" talk in the press, we hope this has been a good year for you. Let us know if we can be of service for any developments.

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Have a great vacation, Dawn!

Dawn Siemer will be taking a vacation visiting family in the Northwest from July 14, returning July 28. Dawn manages our internet operations and our office and she will be sorely missed while she’s away.

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Standard mileage rates increase.

Since fuel prices have increased substantially, the IRS has announced increases in the optional standard mileage rates for the period July 1 through December 31, 2008. The business rate is increasing from 50.5¢ to 58.5¢. The mileage rate for medical and moving is increasing from 19¢ to 27¢. The charitable mileage rate remains unchanged at 14¢. (Announcement 2008-63.)

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Do you own property in a Mexican Residential Trust?

U.S. citizens and residents who own property in a trust set up outside the United States are required to report activities for the trust each year using IRS forms 3520 and 3520-A.

When persons who are not citizens of Mexico own residential real estate in certain areas, including Baja California and Cancún, they are not permitted to take the title individually, but must take the title in a Mexican Residential Trust (MRT) or fideicomiso.

It appears an MRT is subject to the reporting requirements for foreign trusts. There are severe penalties for non-compliance, which the IRS says it will waive provided the late return is filed with a reasonable cause explanation.

See your tax advisor about preparing the form.

Call or write your representatives in Congress to ask to have this requirement repealed for MRTs, or to request that the IRS waive this reporting requirement for MRTs.

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IRS Publication says no basis adjustment if home is foreclosed or sold when principal residence debt is cancelled.

The (new for 2007) federal election to exclude the income from discharge of principal residence indebtedness is made on Form 982 (Re. February 2008), Part I, lines 1.e. and 2. According to IRS Publication 4681, a basis reduction amount is entered at Part II, line 10.b. only if the taxpayer still owns the residence after the debt cancellation.1 IRS Publications aren’t considered legal authority and I haven’t found any other authority for not making a basis adjustment when the debt cancellation happens at the same time as a foreclosure or short sale.

Hopefully the IRS will issue more authoritative guidance in a Revenue Procedure or Ruling in the near future.

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Short sale of investment real estate results in ordinary income from debt cancellation.

During January or February 2002, George and Sharon Stevens of Illinois bought a two-story residence for $256,000 in Chicago, Illinois with the intention of rehabilitating it and then renting it or selling it. They weren’t able to continue making the mortgage payments, so on January 3, 2003, they negotiated a short sale of the residence for $200,000, subject to the approval of the lender.

On February 14, 2003, the Stevenses separated. The short sale closed March 20, 2003.

The lender, Homecomings Financial, issued Forms 1099-C to both George and Sharon Stevens for $74,494.96 cancellation of debt income.

George and Sharon Stevens didn’t report the cancellation of debt income or the sale of the investment property on their separate 2003 income tax returns.

George Stevens represented himself in a small Tax Court hearing.

The Tax Court held the cancellation of debt income was taxable, that no capital loss was realized from the sale of the investment property, and assessed an accuracy-related penalty against George Stevens. Since the property was held in joint tenancy, the Tax Court ruled that George was jointly and severally liable for the mortgage, so the entire cancellation of debt income was taxable to him.

This was a very sad case of kicking a man when he is down. George should not have prepared his own income tax return and he should not have represented himself in Tax Court. The IRS and the Tax Court were harsh in not having Sharon involved in the adjustment.

George didn’t know enough to claim the debt cancellation might not be taxable because of his possible insolvency.

The Tax Court clearly made an error in ruling that no loss was realized for the sale of the property.

It appears this was a rushed ruling where the Tax Court followed the lead of the IRS because George didn’t properly report these transactions and was unable to properly represent himself. He was probably too broke to afford to pay a competent tax lawyer to represent him.

With the recent proliferation of short sales and foreclosures, we will probably see more cases like this one in the near future.

(Stevens v. Commissioner, T.C. Summary Opinion 2008-61, June 3, 2008.)

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Principal residence exclusion allowed for school bus bullying.

Shortly after moving into their home, the daughter of a taxpayer was subjected to bullying, including verbal abuse and sexual assault, while riding a school bus. The daughter was traumatized and her school performance deteriorated. The taxpayer tried to work with the school to resolve the problems, but finally decided to move.

The taxpayer hadn’t lived in the home for more than two years, and requested a ruling that she qualified for an exception for selling the home due to unforeseen circumstances.

The IRS ruled that the taxpayer qualified for the exception.

(Private Letter Ruling 200820016.)

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Questions and Answers

Michael Gray regrets he can no longer personally answer email questions. He will answer selected questions in this newsletter.

Dear readers:

Many of your questions relate to the sale of a principal residence. We have an article at our web site, "Could your residence be the ultimate tax shelter?" (www.realestateinvestingtax.com/residence.shtml) where you should be able to find the answers to most of these questions.


I am 65 years old and I am on the deed along with my daughter and son-in-law. I have heard that seniors can get a break on their real estate taxes. Is this true, and will I be eligible since I am not the only person on the deed?


First, I am assuming you live in California. I suggest that you contact the county assessor’s office in your county for help about the details if you decide to proceed.

The Franchise Tax Board provides a Homeowner Assistance Program to qualified homeowners who are age 62 or older on December 31. You must own and live in your home, but you aren’t required to be the only owner. For 2007, the maximum household income (including your social security and the earnings of your daughter and son-in-law) is $44,096. The maximum assistance payment you can receive is $472.60.

There is also a property tax postponement program. This is a loan for property tax payments from the State of California. The loan plus interest is repaid to the state at your death or when the property is sold. You must be age 62 or older, have at least 20% equity interest in the residence and have a total household income of $33,993 or less.

In order for your family to live in California, it seems likely to me that your household income will exceed the limits, so I’m not going further in this explanation.


I have a home in Maryland that I’ve owned since October 1999. I had to move to Missouri in August 2006 to take care of my grandmother. I began renting my home in Maryland in September 2006. I purchased another home in Missouri in December 2007. Will I have to pay capital gains tax if I sell my home in Maryland in 2009?


If you sell the home before August 2009, you should qualify for the exclusion. You must have used the home as a principal residence for more than two years out of the five years before the sale to qualify. From your explanation, you should have qualified for the years ended July 31, 2005 and July 31, 2006.


If I convert my California home to income, can I write off the cost of improving or adding onto it against any income? Since the improvements will be more than ten times the expected rent, can I average out over time? What will I need to do to make the home owner-occupied to use the $500,000 exclusion?


Improvements to your home that is converted to rental property are capitalized and depreciated. If the improvements are for a residential building, the depreciation is claimed over a 27 ½ year period. Land improvements are depreciated over a 15 year period.

How to qualify for the exclusion from sale of a residence depends on how long you rent the property before you want to sell it.

Don’t you think it’s time to have your income tax returns prepared by a professional preparer? That’s our business!

See IRS Publication 523, Selling Your Home, and IRS Publication 527, Residential Rental Property.

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Michael Gray regrets he can no longer personally answer email questions. He will answer selected questions in this newsletter.

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Michael Gray, CPA
2482 Wooding Ct.
San Jose, CA 95128
(408) 918-3162
FAX: (408) 938-0610
Hours: 8am - 5pm PDT Monday - Friday

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